Part I (22 points) The market for widgets is perfectly competitive. At present, the representative firm is earning economic profits. The cost curves have their usual slopes, and are unaffected by the entry or exit of firms from the industry (so this is a constant cost industry). a) In appropriate diagrams, show the market price and quantity as well as the output and the level of profits of a representative firm. b) For a representative firm, marginal cost equals average total cost at a level of output where average total cost equals 10 and average variable cost equals 8. The minimum of average variable cost is 7. What will the market price be in the long run ? Why? c) Assume that the industry is in long-term equilibrium. If the government decides to provide a grant (subsidy) to one firm, so that the firm’s fixed costs are reduced to zero, what happens to: (i) the market price? (ii) this firm’s level of output? (iii) this firm’s ATC schedule? (iv) this firm’s level of profits?

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Part II (22 points) A monopolist is in long-run equilibrium and earning economic profits. Because unemployment is high, the monopolist is able to reduce the hourly wage rate it pays to workers. a) What will happen to the level of output? to the market price? Illustrate

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